Statement on Monetary Policy - FEBRUARY 2020 - Reserve Bank of Australia

 
Statement on Monetary Policy - FEBRUARY 2020 - Reserve Bank of Australia
Statement on
    Monetary
       Policy
  F E B R UA RY 2 0 2 0
Statement on Monetary Policy - FEBRUARY 2020 - Reserve Bank of Australia
Statement on Monetary Policy - FEBRUARY 2020 - Reserve Bank of Australia
Statement on Monetary Policy
                                                  FEBRUARY 2020

  Contents
     Overview                                                        1

  1. The International Environment                                  5
     Box A: The Recent Economic Slowdown in India                   23
  2. Domestic Economic Conditions                                   27
     Box B: Macroeconomic Effects of the Drought and Bushfires      39
  3. Domestic Financial Conditions                                  43
     Box C: Do Borrowers with Older Mortgages Pay Higher Interest
     Rates?                                                         55
     Box D: Enhancing the Transparency of Interest Rates            59
  4. Inflation                                                      63
  5. Economic Outlook                                               71
The material in this Statement on Monetary Policy was finalised on 6 February 2020. The next Statement is due for release on
8 May 2020.

The Statement is published quarterly in February, May, August and November each year. All the Statements are available at
www.rba.gov.au when released. Expected release dates are advised ahead of time on the website. For copyright and
disclaimer notices relating to data in the Statement, see the Bank's website.

The graphs in this publication were generated using Mathematica.

Statement on Monetary Policy enquiries:

Secretary's Department
Tel: +61 2 9551 8111
Email: rbainfo@rba.gov.au

ISSN 1448–5133 (Print)
ISSN 1448–5141 (Online)
Overview

Monetary policy was eased in 2019 to support           outlook for the Australian economy is broadly
employment and income growth and to provide            unchanged from three months ago.
greater confidence that inflation will be              GDP growth is expected to improve over the
consistent with the medium-term target. This           course of this year and next. Growth is expected
policy response is supporting the overall growth       to be 2¾ per cent over 2020 and around
outlook through a number of channels. The              3 per cent over 2021. This is a step up from the
Australian dollar is lower than it otherwise would     growth rates recorded over the previous two
be as a result of the policy easing; it is now         years. Part of this recovery reflects the expected
around the bottom of its range in recent years.        transmission of the low level of interest rates to
Interest rates faced by both borrowers and             the housing market and household spending. A
lenders are now at very low levels. The lower          turnaround in mining investment is also
interest rates have contributed to increased           expected, consistent with the publicly
demand for both new and existing homes. They           announced investment plans of firms in that
also lower required debt payments for many             sector. The recovery effort following the
households. The resulting extra cash flows can         bushfires is likely to reverse the negative near-
be spent or used to pay down debt faster,              term economic effects of the fires on aggregate
although this benefit is partly offset by reduced      activity, but drought conditions are likely to
interest income for savers. The effects of the         continue to weigh on rural production and
recent rate reductions take time to work their         exports for a while yet.
way through the economy and have their full
                                                       The transmission of monetary policy is evident
impact on spending. Some of the early stage
                                                       in established housing markets. Housing prices
channels of policy transmission, such as new
                                                       have turned around noticeably, especially in
borrowing, higher asset prices and a depreci-
                                                       Sydney and Melbourne. Housing turnover,
ation of the exchange rate, are nonetheless
                                                       which is an important driver of some types of
proceeding as normal.
                                                       household spending, has increased, as has new
The low level of interest rates in Australia reflect   borrowing, particularly by owner-occupiers. It is
the low interest rates globally as well as the only    too soon to see any response to this in
gradual progress towards the Bank’s goals, as the      household spending, but over time the drag on
Australian economy navigates a period of slow          consumption growth from the earlier decline in
growth. This soft patch in growth is likely to         housing prices and activity should wane. That
extend into early 2020 because of the ongoing          said, at this stage it cannot be ruled out that the
drought, the effects of the bushfires, and the         sharp fall in housing prices has reduced the level
effects on Australian exports of the recent            of debt that households feel comfortable
outbreak of a new coronavirus in China. Beyond         carrying, even after housing prices recover. So
these shorter-term effects, the medium-term            the effect of the cycle in housing prices on

                                                        S TAT E M E N T O N M O N E TA R Y P O L I C Y – F E B R UA R Y 2 0 2 0   1
spending might last longer than historical           confidence was most likely to be a reaction to
    experience implies. The forecast for consump-        the same developments that prompted recent
    tion takes some account of this.                     policy easing, rather than to the rate reductions
    A recovery in dwelling investment is likely to       themselves. That said, the consumption outlook
    occur towards the end of this year in response to    remains uncertain and its evolution will
    lower interest rates as well as the strong growth    continue to be an important focus of the Board.
    in established housing prices and population         In line with the expected pick-up in GDP growth,
    growth. Early indicators of demand and sales are     employment growth is expected to increase
    already showing signs of turning around, which       over time, after having eased a little lately. As this
    gives more confidence that the recovery will         occurs, the unemployment rate should also
    proceed as expected.                                 come down. The unemployment rate declined
    A key consideration for monetary policy remains      slightly through the December quarter, to be
    the outlook for consumption. In the September        5.1 per cent in the month of December. It is
    quarter, consumption growth was weaker than          expected to remain in the 5–5¼ per cent range
    earlier expected, and it is likely to remain         for some time before declining to around
    subdued in the December quarter. Recent data         4¾ per cent in 2021. The central forecast does
    have been consistent with households gradually       not envisage a repeat of the recent unusually
    adjusting their spending to the slower trend rate    strong increase in labour force participation, but
    of income growth and it appears that                 this cannot be ruled out if employment growth
    adjustment may have accelerated in response to       turns out to be stronger than expected.
    the prior period of falling housing prices.          Wages growth has been low and steady for
    Consistent with this, there was also an increase     some time, in line with the spare capacity still in
    in mortgage payments over the second half of         the labour market, as well as the constraints
    last year. Tax cuts and interest rate reductions     implied by the wages policies of various govern-
    helped support income in the September               ments. As the unemployment rate declines and
    quarter, although consumption remained               the labour market tightens, some limited
    subdued in the face of this balance sheet            upward pressure on wage outcomes can be
    adjustment.                                          expected.
    Consumption growth is expected to recover            Inflation remains low and stable. The recent
    gradually over the course of this year and next.     inflation data were in line with our expectations
    The low level of interest rates, a somewhat faster   and confirmed a modest lift in CPI inflation over
    rate of income growth than in recent years and       recent quarters to 1.8 per cent. Trimmed mean
    the recovery in household wealth are all             inflation was a little lower at 1.6 per cent. Both
    expected to contribute to this turnaround.           measures are forecast to increase gradually to
    Lower rates have been assisting with the             2 per cent over the next couple of years. The
    ongoing adjustment in household balance              outlook for inflation in part rests on the expec-
    sheets by reducing debt-servicing costs. The         tation that the drag coming from housing-
    Board took note that some survey measures of         related inflation will dissipate as the housing
    confidence about the future had declined,            market recovers following the easing in
    although measures of current business                monetary policy. Early signs of this are evident in
    conditions and households’ views about their         reduced discounting of the prices of newly built
    finances, which tend to be more indicative of        houses in the December quarter. Retail price
    economic decisions, remain around average.           inflation has generally been subdued, but the
    The Board therefore assessed that the decline in

2   R E S E R V E B A N K O F AU S T R A L I A
drought has been putting upward pressure on          In considering this case, the Board has taken
the prices of an increasing range of food items.     account of the fact that interest rates have
The outlook for the Australian economy has in        already been reduced to a low level and there
part been shaped by the evolving global              are long and variable lags in the transmission of
outlook. The global economy has clearly              monetary policy. The Board also recognises that
suffered over the past year from the uncertainty     a balance needs to be struck between the
and interruption to international trade caused       benefits of lower interest rates and the risks
by the US–China trade and technology disputes.       associated with having interest rates at very low
Towards the end of 2019 and early 2020,              levels. Internationally, there are increasing
indications were that global growth was poised       concerns about the effect of very low interest
to improve. The phase one partial trade deal         rates on resource allocation in the economy and
between the United States and China has              their effect on the confidence of some people.
reduced the tensions between the two                 Lower interest rates could also encourage more
countries. This has alleviated but not eliminated    borrowing by households eager to buy
an important source of uncertainty around the        residential property at a time when housing
global outlook. It has also contributed to the       debt is already quite high and there is already a
accommodative financial conditions.                  strong upswing in housing prices in place. If so,
                                                     this could increase the risk of problems down
The outbreak of the coronavirus and the efforts
                                                     the track.
of authorities in China and elsewhere to contain
its spread represents a new source of                After considering this balance, the Board
uncertainty. This will reduce Chinese and global     decided to maintain the cash rate unchanged at
growth in the short term. With the situation still   its recent meetings. It recognises, though, that
evolving, it is very uncertain how much growth       the balance between benefits and risks can
will slow or for how long. Previous outbreaks of     change over time and it is dependent upon the
new viruses have had significant, but short-lived,   state of the economy. If the unemployment rate
negative effects on economic growth in the           were to be moving materially higher and there
economies at the centre of the outbreak. It is       was no further progress being made towards
difficult to know how representative these           the inflation target, the balance of arguments
earlier episodes could be. The economic impact       would tilt towards a further easing of monetary
will depend crucially on the duration of its         policy. The Board will continue to monitor
impact and measures taken to contain the             developments carefully, including in the labour
spread of the virus.                                 market.

The forecasts imply progress towards the
inflation target and full employment, but that
progress is expected to be only gradual. To
maintain this progress, monetary policy is very
likely to remain accommodative for some time.
Given the only gradual nature of the progress,
the Board has been discussing the case for a
further easing of monetary policy in order to
speed the pace of progress and to make it more
assured in the face of ongoing uncertainties.

                                                      S TAT E M E N T O N M O N E TA R Y P O L I C Y – F E B R UA R Y 2 0 2 0   3
4   R E S E R V E B A N K O F AU S T R A L I A
1. The International Environment

The global outlook remains reasonable but            US–China trade and technology
uncertain. In January, the United States and         tensions have eased which is supportive
China signed a partial trade agreement thereby       of global growth …
de-escalating their dispute over trade and           Since October there have been some positive
technology. This has reduced, but not                developments on the US–China trade and
eliminated, a key downside risk to global growth     technology disputes. Threatened tariff increases
and, together with some more positive signs in       in October and December 2019 were cancelled
global economic data, supported forecasts for a      as the United States and China negotiated the
pick-up in global growth in 2020 and 2021. More      limited phase one trade agreement signed in
recently, however, the outbreak of a new strain      January. The agreement provides for a small
of coronavirus is expected to weigh on near-         reduction in overall tariffs, increased Chinese
term growth and has created a new uncertainty        purchases of US products and some steps to
for the outlook.                                     address US concerns about market access and
Developments in global financial markets over        the protection of intellectual property. Despite
recent months have reflected evolving                the agreement, tariffs between the two
perceptions of these key risks. Overall though,      countries remain around the highest they have
global financial market conditions remain            been in about 30 years after they were increased
supportive of economic growth. Following a           to nearly 20 per cent in 2018 and 2019.
period in 2019 of monetary easing, central banks     There have also been signs of stabilisation in
in advanced economies have indicated that            global manufacturing and trade since late 2019
their current policy settings are likely to remain   (Graph 1.1). However, most of these indicators
appropriate for some time, though they remain        remain at subdued levels, as do business
prepared to ease further if necessary. Long-term     investment intentions. Spillovers from the
government bond yields had risen as concerns         weakness in conditions for export-oriented
about key downside risks eased, but have since       sectors have been limited so far partly because
declined noticeably and are back at very low         of support from stimulatory policy. Consump-
levels. Corporate financing conditions have          tion growth has generally remained resilient
generally remained favourable; credit spreads        through the past year. Employment growth has
are at low levels and equity prices have generally   slowed a little in the major advanced economies
risen further over the past couple of months,        but labour markets remain tight. Despite that,
notwithstanding recent declines.                     inflation remains low and below most central
                                                     banks’ targets.
                                                     The easing in trade tensions between the United
                                                     States and China, and signs of stabilisation in a
                                                     number of economic indicators, led to small

                                                      S TAT E M E N T O N M O N E TA R Y P O L I C Y – F E B R UA R Y 2 0 2 0   5
improvements in the underlying growth outlook                                     outbreak. If it persists for an extended period,
    for a number of economies. Forecasts released                                     the effect on economic activity is likely to be
    by the International Monetary Fund in mid                                         larger than currently projected. The outlook for
    January showed global growth picking up in                                        China, and how policy responses there could
    2020 and 2021, led by emerging market and                                         affect China’s demand for Australia’s exports and
    developing economies.                                                             the exports of Australia’s other key trading
                                                                                      partners in Asia, remains an important
    … but the coronavirus outbreak has                                                consideration for the Australian economy.
    lowered the near-term growth outlook                                              A number of other downside risks remain.
    and increased uncertainty                                                         Despite the recent positive developments in
    The recent outbreak of a new strain of                                            US–China negotiations, an escalation in the
    coronavirus has lowered the near-term growth                                      dispute remains a key downside risk to the
    outlook for China and some other economies,                                       outlook given the limited nature of the phase
    particularly in Asia. In China, economic effects                                  one deal and the potential for renewed tensions
    include lower domestic travel and other                                           to weigh on trade and investment.
    consumption, and disruption to the movement                                       Considerable uncertainty also remains for other
    of goods. Also, business shutdowns will                                           trade arrangements. The United States
    negatively affect industrial production and                                       postponed a decision on possible actions
    services. The effects of the outbreak are likely to                               affecting automotive imports from the European
    flow through to other economies, particularly in                                  Union. The trade dispute between Japan and
    east Asia, including via sharply lower Chinese                                    South Korea has raised uncertainty about supply
    outbound tourism, weaker Chinese demand for                                       in the South Korean semiconductor industry and
    other exports and disruption to global supply                                     reduced tourism flows between the two
    chains. As China and east Asia are large trading                                  countries. The United Kingdom formally exited
    partners for Australia, overall growth in                                         the European Union in January under a short
    Australia’s major trading partners is expected to                                 transition arrangement, reducing the prospects
    be a little lower in 2020 before picking up in                                    of a disorderly near-term breakdown of the
    2021 (Graph 1.2).                                                                 UK–EU trading relationship, although the
    There is considerable uncertainty regarding the                                   ultimate form of the trading relationship remains
    duration and severity of the coronavirus

                                                                                                                       Graph 1.2
                                     Graph 1.1                                                                   Global GDP Growth
                                                                                                                          Year-average
                           Global Economic Conditions                                    %
                                                                                                                                                   Forecasts
                                                                                                                                                                        %
        %                                                                     index                                     Australia’s major
                           Trade                 Purchasing Managers’ Index
                 Imports                                                                                                trading partners*
                                                                                         6                                                                              6
                 growth*
                  (LHS)
         4                                                                    56
                                                       Services
                                                         (RHS)                           4                                                                              4

                                                                                                                                                     World**
         2                                                                    53
                                                                                         2                                                                              2

         0                                                                    50         0                                                                              0
                                                      Manufacturing
                                                          (RHS)
                  New export orders
                          (RHS)                                                          -2                                                                             -2
        -2                                                                    47                   1991      1997         2003         2009         2015         2021
                           2016          2020            2016         2020                    *   RBA forecasts as at February 2020; Australian export share-weighted
             *   Smoothed; year-ended growth                                                  **  IMF forecasts as at January 2020; PPP-weighted
             Sources: CPB Netherlands; Markit; RBA                                            Sources: CEIC Data; IMF; RBA; Refinitiv

6    R E S E R V E B A N K O F AU S T R A L I A
uncertain. The future functioning of the World       creates a new uncertainty. At this stage, growth
Trade Organization is also unclear. By contrast,     is expected to decrease significantly in the
lingering uncertainty about the United States,       March quarter before rebounding later in the
Mexico and Canada trade agreement was                year, although the situation is very dynamic and
alleviated when it was passed by the US              the timing over Chinese New Year will make the
Congress in January.                                 economic impact especially difficult to read.
                                                     Conditions in Chinese property markets
In China, growth appeared to stabilise in            remained mixed in the December quarter
late 2019                                            (Graph 1.5). Property prices continued to rise,
In China, GDP growth slowed in 2019, to              although the pace of price growth has been
6.1 per cent compared with 6.7 per cent in 2018.     moderating for some time. Sales declined in the
The slowdown was driven by domestic demand,          quarter, while spending on construction and
and was mostly the result of longer-term             fittings remained robust. Local governments
structural factors and ongoing actions to reduce     continued to tailor housing policies to account
risks in the financial sector. Uncertainty           for local conditions, with restrictions eased in
associated with the US–China trade and               some areas to offset weak conditions.
technology dispute is also likely to have affected
investment decisions, and growth in retail sales
has been easing.
                                                                                       Graph 1.3
Over the course of the December quarter,                                 China – Activity Indicators*
                                                                                            Growth
however, a range of indicators of Chinese               %
                                                                 Real fixed asset investment            Real retail sales
                                                                                                                                   %

activity recovered somewhat (Graph 1.3 and              40                                                                         20
                                                                         Year-ended
Graph 1.4). This suggested that targeted fiscal
                                                        30                                                                         15
and monetary easing were helping to stabilise
economic conditions. Growth in fixed asset              20                                                                         10

investment strengthened, driven by a pick-up in         10                                                                         5
investment in the manufacturing sector.
                                                         0                                                                         0
Industrial sector indicators also showed some                       Quarterly

signs of improvement in the December quarter.          -10
                                                                     2009       2014      2019        2009      2014        2019
                                                                                                                                   -5

Growth in industrial production picked up,                   *   Seasonally adjusted by the RBA
                                                             Sources: CEIC Data; RBA
particularly for the output of construction
materials such as steel and plate glass. Car
production also increased modestly after                                               Graph 1.4
declining over the past couple of years, and                           China – Industrial Production
                                                                                       Year-ended growth
producer prices stopped declining as the                %                                         Three-month moving average %
deflationary effect of falling raw materials and
                                                                  Value-added
manufactured goods prices began to abate.                                                           Steel products
                                                        10                                                                         15
                                                                                                           Electricity
The January trade agreement with the United                                                                generation

States should have alleviated some of the
uncertainty affecting investment, and local              0                                                                         0
                                                             Gross output
governments are also in a position to rekindle
                                                                                                     Crude steel
infrastructure investment growth now that
                                                       -10                                                                         -15
preliminary bond issuance quotas have been                2011              2015          2019               2015           2019

released. However, the coronavirus outbreak                  Sources: CEIC Data; RBA

                                                      S TAT E M E N T O N M O N E TA R Y P O L I C Y – F E B R UA R Y 2 0 2 0            7
Core consumer price inflation continued its                                                Chinese authorities have announced
    gentle downward trend and was 1.4 per cent in                                              further targeted policy easing
    December (Graph 1.6). Headline inflation                                                   Chinese policymakers have continued to
    increased sharply as pork supply shortages                                                 balance their objectives of supporting economic
    caused by the outbreak of African swine fever                                              growth and reducing risks in the financial
    drove large increases in pork prices and other                                             system. Fiscal and monetary policy measures
    meat products. Pork prices have declined a little                                          have been modest overall and generally focused
    from their peak in December, reflecting signs                                              on specific areas of weakness in the economy –
    that pork production is beginning to recover,                                              namely, public infrastructure spending and
    but prices are expected to remain elevated for                                             access to finance for small and private sector
    some time.                                                                                 firms. More recently, the authorities have
                                                                                               announced some measures to support liquidity
                                                                                               and bank lending in the near term to alleviate
                                                                                               disruptions related to the coronavirus. It remains
                                                                                               unclear at this stage whether additional support
                                                                                               will be needed in response to the virus.

                                       Graph 1.5                                               To support infrastructure spending, local
                China – Residential Property Indicators                                        governments were given a preliminary
                                      Year-ended growth
       %             New property prices                       Investment**              ppt   allocation of their 2020 special bond issuance
                 Alternative*                        Land purchases                            quota so that they could plan for, fund, and
       15                                                                                20
                                                                                               begin work on eligible infrastructure projects
        0                                                                                0
                          Official                                                             before the final quota is set at the National
                                                      Other investment***
       %                                                                                 %
                                                                                               People’s Congress in March. The preliminary
                      Floor space sold                         Inventory
                                                                                               allocation of CNY 1 trillion was around
       50                                                                                25
                                                                                               25 per cent higher than the equivalent
        0                                                                                0
                                                                                               allocation granted in 2019 and local govern-
      -50                                                                                -25   ments have responded by issuing these bonds
                        2016             2019                 2016               2019
            *   China Index Academy                                                            earlier than in previous years (Graph 1.7). The
            **  Contributions of residential and non-residential investment to
                year-ended growth                                                              authorities also reduced the amount of equity
            *** Construction, installation, equipment purchases and other
            Sources: CEIC Data; CIA; CRIC; RBA                                                 capital required for some infrastructure projects
                                                                                               including for ports, roads, rail, logistics and
                                                                                               ecological protection.
                                       Graph 1.6
                                     China – Inflation*
                                                                                               The People’s Bank of China (PBC) reduced the
       %
                                           Year-ended
                                                                                         %
                                                                                               reserve requirement ratio by 50 basis points for
                     Consumer prices                       Producer prices
                                                                                               all financial institutions in January (Graph 1.8). In
        8                                                                                10
                      Headline                                                                 part, this was aimed at ensuring sufficient
                                                                                               liquidity ahead of Chinese New Year. In late 2019,
        4                                                                                5
                                                                                               the PBC also marginally reduced the interest
        0                                                                                0     rates on its short-term and medium-term
                        Core
                                                                                               lending operations. Subsequently, the one-year
       -4                                                                                -5
                                                                                               Loan Prime Rate (LPR), the new reference rate for
       -8                                                                                -10
                                                                                               non-mortgage lending by Chinese banks,
                   2009        2014        2019         2009         2014         2019
            *   Seasonally adjusted by the RBA
                                                                                               declined by 5 basis points. In addition,
            Sources: CEIC Data; RBA
                                                                                               authorities implemented further measures to

8   R E S E R V E B A N K O F AU S T R A L I A
support financing conditions for micro and small                      most new loans issued had already been
enterprises (MSEs). In particular, the State                          referencing the LPR. The LPR is linked to the rate
Council called upon banks to lower financing                          offered by the PBC on its medium-term lending
costs for some MSEs by 50 basis points and                            facility (MLF), so interest rate changes by the PBC
instructed the five largest commercial state-                         will directly affect lending rates. However, to
owned banks to increase the value of loans                            avoid overstimulating the housing market,
extended to MSEs by 20 per cent over the next                         authorities have stated that mortgage rates
year. Growth in total social financing (excluding                     must remain unchanged at the time of
government bond issuance) has remained                                conversion and that the repricing period must
stable in year-ended terms but declined in the                        be at least one year. This means that mortgage
December quarter because off-balance sheet                            rates will not change until at least 2021, even if
financing contracted more quickly than earlier in                     the PBC reduces the MLF rate.
the year. More recently, authorities announced a
range of measures to avoid a tightening in                            Growth in east Asia also appeared to
financial conditions as a result of the coronavirus                   stabilise in late 2019
outbreak. In particular, the PBC has pledged to                       Growth indicators in east Asia stabilised in late
maintain adequate liquidity in the system and                         2019 following a period when weak external
has encouraged banks to reduce lending rates                          demand, particularly from China, and the effects
to assist firms affected by the outbreak.                             of the US–China trade dispute on global supply
As part of ongoing efforts by the Chinese                             chains had weighed on growth. The levelling
authorities to improve the transmission of                            out in activity indicators in the region is
monetary policy and the transition towards                            consistent with more favourable trade develop-
market-based pricing of financial products, the                       ments evident since October 2019. After a
PBC announced the next stage of its lending                           period of decline, industrial production has been
rate reform in late 2019. The PBC instructed                          flat in recent months, while surveyed manufac-
banks to begin shifting the outstanding stock of                      turing sector conditions and new export orders
loans to reference the LPR from March 2020, and                       have picked up somewhat (Graph 1.9).
it expects this transition to be complete by the                      Merchandise export volumes have been largely
end of August. Banks were also instructed to                          flat over the past year, supported by relatively
cease issuing new loans that referenced the old                       resilient semiconductor exports. However, weak
benchmark rate from 1 January 2020, although

                               Graph 1.7                                                                 Graph 1.8
                                                                                             Chinese Monetary Policy
             Chinese Local Government Bonds                              %                                                                                  %
                                                                                  Reserve requirement ratio                     Interest rates
                           New issuance, cumulative
CNYtr                                                         CNYtr
                 Special bonds                General bonds
                                                                                        Large banks
                                                                         20                                                                                 8

                                                                                                                                        Average loan
   2                                                          2                     Medium                                                  rate
                            2019                                         15                                                                                 6

                                                                                                                                          Five-year
                                                                                                                                             LPR
                                   2018
                                                                         10                                                                                 4
   1                                                          1                                                                               One-year
                                                                                                                        One-year loan
          2020                                                                                     Small*                                       LPR
                                                                                                                       benchmark rate
                                   2017
                                                                          5                                                                                 2
                                                                                   2012         2016          2020        2012         2016          2020
   0                                                          0               *   Not published prior to April 2018. Note this rate is a guideline and
        J FMAM J J A S ON D J FMAM J J A S ON D                                   does not apply to all small banks.
        Source: WIND Information                                              Source: CEIC Data

                                                                       S TAT E M E N T O N M O N E TA R Y P O L I C Y – F E B R UA R Y 2 0 2 0                  9
memory chip prices have weighed on export                                              GDP growth in most of the export-oriented
     values, particularly in South Korea and                                                economies in the region was subdued over
     Singapore, and on business profits and                                                 2019 because business investment and exports
     investment. More recently, memory chip prices                                          have weighed on growth (Graph 1.11). In South
     appear to have bottomed out, which should                                              Korea, weak residential investment and softer
     support future activity and investment in this                                         household consumption have also contributed
     key sector for the region (Graph 1.10). The easing                                     to the weakest GDP growth in a decade,
     of US–China trade tensions, signs of a                                                 although public consumption has supported
     turnaround in the global electronics cycle and                                         growth and fiscal policy is expected to be very
     more stimulatory policies are supportive of                                            expansionary in 2020. In contrast, GDP growth in
     slightly stronger growth in east Asia over the                                         Vietnam has been strong, boosted by export
     next couple of years. However, the coronavirus                                         growth to the United States as some production
     outbreak in China is expected to weigh on                                              has been relocated from China in response to
     growth in the region in early 2020 because of                                          the US–China trade dispute. Activity has also
     the disruption to Chinese traveller flows and                                          picked up in some of the less export-oriented
     supply chains.                                                                         economies in the region, such as the Philippines.
                                                                                            Growth in Indonesia has been steady, driven by
                                                                                            relatively resilient consumption growth.
                                       Graph 1.9
                                                                                            Ongoing political unrest continues to weigh
                     East Asia – Production and Trade
      index                     Production and new export orders                    index   heavily on Hong Kong economic activity.
       108                                                                          53
                                                                                            Inflation remains low in east Asia. Inflation in
       100                                                                          50
                                                                                            South Korea has been especially low and well
        92                                                                          47
                    Industrial production*                New export orders
                            (LHS)                                (RHS)                      below target, although headline inflation picked
      index                                     Trade*                              index
                                                                                            up sharply in January (Graph 1.12). Inflation in
       115                                                                          115
                  Merchandise export values                                                 Indonesia has been relatively steady, while it has
       100                                                                          100
                                                                                            been quite volatile in Malaysia following
        85                                                                          85
                     Merchandise export volumes                                             changes in consumption taxes. In the
        70                                                                          70
                  2012          2014            2016          2018           2020           Philippines, inflation rose again as domestic
              *   Average since 2012 = 100
              Sources: CEIC Data; Markit; RBA

                                       Graph 1.10                                                                          Graph 1.11
                    Semiconductor Industry Indicators                                                             East Asia – GDP Growth
                                       Year-ended growth                                                              Year-ended with contributions
         %                                                                          %          %        Export-oriented east Asia*                                        %
                           East Asia                       Global sales                                                                     Less-export-oriented
                                                                                                                                                east Asia**
        50                                                                          20
                     Production*
                                                                                               4                                                                          4
        25                                                                          10

         0                                                                          0
                                                                                               0                                                                          0
                                                                                                                                            GDP
       -25                                                                          -10                                                     Exports
                                  Prices**                                                                                                  Investment
                                                                                                                                            Other
       -50                                                                          -20        -4                                                                         -4
                         2015             2019            2015               2019                              2015             2019              2015             2019
              *   Weighted aggregate of South Korea, Malaysia, Singapore, Taiwan                    *   Includes Hong Kong, Malaysia, Singapore, South Korea, Taiwan
                  and Thailand                                                                          and Thailand
              ** South Korea memory chip export prices                                              ** Includes Indonesia and the Philippines
              Sources: CEIC Data; RBA; Refinitiv                                                    Sources: CEIC Data; RBA

10   R E S E R V E B A N K O F AU S T R A L I A
activity picked up and as food prices increased                                           Economic activity in India
because of weather-related factors.                                                       slowed further
Monetary policy became more accommodative                                                 Economic growth in India has slowed sharply
in the region over 2019 to support growth                                                 since early 2018, reflecting ongoing weakness in
against the backdrop of low inflation and amid                                            domestic demand (see ‘Box A: The Recent
reduced concerns about capital outflows                                                   Economic Slowdown in India’). In the September
(Graph 1.13). For a few economies in the region                                           quarter, exports contracted while public
there was a pause in the policy easing cycle in                                           consumption helped support growth. Credit
late 2019 driven by an expectation that earlier                                           provision to the services sector has contracted in
episodes of monetary and fiscal easing would                                              recent months despite the government and the
support the economic outlook. More recently,                                              Reserve Bank of India (RBI) taking a number of
however, some central banks have highlighted a                                            measures to encourage both bank and non-
willingness to ease policy further in response to                                         bank lending. The slowdown in growth has
the effects of the coronavirus.                                                           been larger than expected. There are some
                                                                                          tentative signs, however, that growth will
                                                                                          stabilise soon: car sales have increased in recent
                                                                                          months after declining since mid 2018; air
                                                                                          passenger traffic growth has picked up in recent
                                 Graph 1.12
                                                                                          months; and, in the December quarter, capital
                   East Asia – Headline Inflation
                                       Year-ended                                         expenditure increased for the first time since the
   %                                                                                 %
                                                                                          June quarter of 2018 (Graph 1.14). Even so, any
                                  Indonesia
   8                                                                                 8    pick-up in growth is likely to be modest in the
                                                    Philippines
   6                                                                                 6    near term. Indicators of industrial sector activity
                                                                                          are weak and credit conditions remain
   4                                                                                 4
                                                                                          challenging.
   2                                                                                 2
                                                                                          Headline inflation increased to be above the top
             South Korea
   0                                                                                 0    of the RBI’s target range, reflecting damaged
                                                        Malaysia
   -2                                                                                -2
                                                                                          crops and higher vegetable prices following
            2012          2014              2016              2018            2020
        Sources: CEIC Data; RBA
                                                                                          heavy rainfall late in the monsoon season
                                                                                          (Graph 1.15). This was accompanied by a sharp

                                 Graph 1.13
                                                                                                                          Graph 1.14
                            Asia – Policy Rates
   %                                                                                 %                 India – Economic Activity Indicators
                                                                                                         Three-month moving average, year-ended growth
                                                                                              %                                                                   %
                                                                                                             Consumption                      Investment
   8                                                                                 8
                                                                                                      Air passenger
                                                                                                           traffic
                       Indonesia*                     India
                                                                                             15                                                                   15
   6                                                                                 6                                                    Capital
                                                                                                                                        expenditure
                               Philippines
   4                                                                                 4         0                                                                  0

                               Malaysia
   2                                                                                 2
                                                                                             -15                                                                  -15
                                              Thailand                                                      Passenger vehicle             Capital goods
                                                                                                                 sales                     production
   0                                                                                 0
            2012          2014              2016              2018            2020
        *   Dashed line indicates a change in official policy rate for Indonesia             -30                                                                  -30
            (August 2016)                                                                       2011             2015           2019            2015       2019
        Source: Central banks                                                                      Sources: CEIC Data; RBA; Refinitiv

                                                                                          S TAT E M E N T O N M O N E TA R Y P O L I C Y – F E B R UA R Y 2 0 2 0       11
increase in household inflation expectations. In                                      GDP growth in the United States eased to
     response, the government eased restrictions on                                        around trend over 2019. Business investment
     onion imports and banned onion exports. Price                                         declined and investment intentions eased
     pressures have moderated in most other                                                sharply (Graph 1.18). Consumption growth
     expenditure categories and core inflation                                             slowed a little in late 2019, although it remains
     remains relatively subdued. The RBI kept its                                          firm and consumer confidence is high
     policy rate unchanged in December, citing the                                         (Graph 1.19). Lower interest rates have
     less favourable inflation environment and its                                         supported a pick-up in residential investment.
     expectation that the lagged effects of monetary                                       The US growth outlook is also a little stronger
     and fiscal stimulus implemented in 2019 will                                          than three months ago because reduced
     support activity. It noted that there is space for                                    uncertainty around trade is expected to support
     further monetary easing if required.                                                  business investment, and the resilient labour
                                                                                           market is expected to continue supporting
     Activity in major advanced economies                                                  consumption. GDP growth over the next two
     slowed in 2019 but there have been                                                    years is expected to continue at around its
     signs of stabilisation
     Growth in the major advanced economies was
     slower in 2019 than in 2018 (Graph 1.16). Manu-                                                                             Graph 1.16
     facturing activity declined, especially in the euro                                                      Major Advanced Economies –
                                                                                                                      GDP Growth
     area, external demand has been weak and                                                   %
                                                                                                        United States               Euro area             Japan
                                                                                                                                                                         %

     services activity has eased. In this environment,
                                                                                                        Year-ended
     and amid uncertainty about trade and                                                      4                                                                         4

     technology policies, growth of investment has
     eased. However, consumption growth has                                                    2                                                                         2

     remained resilient because it has been
     supported by tight labour markets. More                                                   0                                                                         0
                                                                                                        Quarterly
     recently there have been signs of stabilisation in
     the manufacturing sectors of these economies                                              -2
                                                                                                        2014           2019        2014      2019      2014       2019
                                                                                                                                                                         -2

     and in US investment intentions (Graph 1.17).                                                  Sources: RBA; Refinitiv

                                      Graph 1.15                                                                                 Graph 1.17
                        India – Consumer Price Index                                                          Major Advanced Economies –
                                       Year-ended growth
         %                                                                            %                           Business Conditions
                                                                                                                         Purchasing Managers’ Index
                                                                                            index                                                                        index
         16                                                                           16                United States               Euro area             Japan

                                      Headline                                                       Services                     Manufacturing
         12                                                                           12      60                                                                         60
                                                            Excluding
                                                          food and fuel*
          8                                                                           8

                                                                                              55                                                                         55
          4                                                                           4

          0                                                                           0       50                                                                         50
                                                         Monthly
                                                                                                           ISM
         -4                                                                           -4
                  2007            2010           2013           2016           2019                    manufacturing
              *   Constructed by the RBA; food and fuel comprise 52.7 per cent of             45                                                                         45
                  the CPI basket                                                                         2016           2020        2016        2020   2016       2020
              Sources: CEIC Data; RBA                                                               Sources: Markit; Refinitiv

12    R E S E R V E B A N K O F AU S T R A L I A
current pace, which is consistent with potential                                             sector to the services sector and the labour
growth.                                                                                      market. Euro area growth is expected to remain
In the euro area, GDP growth has been subdued                                                weak over the next two years because external
over the past two years because of pervasive                                                 demand is expected to recover only gradually
weakness in external demand. This has                                                        and uncertainty persists about key trading
particularly affected economic conditions in                                                 relations, including with the United Kingdom.
Germany, where industrial production has                                                     Japanese economic activity slowed following
declined significantly. Survey indicators of                                                 the consumption tax increase in October 2019.
conditions in the manufacturing sector remain                                                As was expected, consumption and residential
very weak. The investment outlook in the euro                                                investment indicators fell sharply after the tax
area is subdued. Investment intentions and                                                   increase following strong growth in the middle
industrial confidence are well below average                                                 of the year as activity was brought forward.
levels. Consumption has remained firm so far,                                                Surveyed conditions in the services sector,
despite some spillovers from the industrial                                                  which had been quite resilient, declined in the
                                                                                             December quarter but largely recovered in
                                                                                             January. Business investment growth, while still
                                 Graph 1.18                                                  strong, has slowed and investment intentions
                  Major Advanced Economies –                                                 have eased. Industrial production has declined
                     Investment Indicators
   %
              United States             Euro area                  Japan
                                                                                      std    in recent months and conditions in the manu-
                                                                                      dev
                                                                                             facturing sector remain around their recent lows,
   20                                                                                 4      partly because of the disruption from the
              Capital goods           Investment
                 orders*               intentions**                                          consumption tax increase and partly because of
                  (LHS)                   (RHS)
   10                                                                                 2      weak external demand. The coronavirus
                                                                                             outbreak in China is also likely to lower traveller
    0                                                                                 0      flows from China significantly in early 2020.
                                                                                             However, fiscal stimulus, focused on infras-
  -10
               2014        2020         2014        2020         2014          2020
                                                                                      -2     tructure and equivalent to around 1 per cent of
        *
        **
            Year-ended growth                                                                GDP, has been announced to support growth in
            Smoothed for US
        Sources: Bank of Japan; RBA; Refinitiv                                               2020 and early 2021. Accordingly, the outlook for
                                                                                             Japan is little changed in net terms; growth is
                                                                                             expected to dip below trend in late 2019 and
                                 Graph 1.19                                                  early 2020, before gradually recovering to
                  Major Advanced Economies –                                                 around trend growth in 2021 as external
                    Consumption Indicators
  std
             United States              Euro area                  Japan
                                                                                      %      demand improves.
  dev                                                             Consumption
                                                                    indicator*
                                                                       (RHS)
   2                                                                                  2.5
                                                                                             Labour market conditions have eased
                                                                                             but remain tight
   0                                                                                  0.0
                  Consumer
                                                                                             Employment growth in the major advanced
                  sentiment
                      (LHS)                                                                  economies has slowed since early 2019,
   -2                                                                                 -2.5
                                                                                             particularly in the manufacturing sector. Near-
                                                                                             term forward-looking indicators of labour
   -4                                                                                 -5.0
               2014        2020         2014        2020         2014         2020           demand, such as vacancy rates and employ-
        *   Year-ended growth; smoothed; personal consumption expenditure
            for United States, retail sales for euro area and consumption index
            for Japan
                                                                                             ment intentions, have eased a little but are still
        Sources: CEIC Data; RBA; Refinitiv
                                                                                             at high levels (Graph 1.20). Nonetheless, employ-

                                                                                             S TAT E M E N T O N M O N E TA R Y P O L I C Y – F E B R UA R Y 2 0 2 0   13
ment growth remains above working-age                                                 since August. Inflation in the euro area has
     population growth and therefore unemploy-                                             increased since October, largely due to stronger
     ment rates, which are already at multi-decade                                         services and food inflation. Inflation has been
     lows, continue to fall. Wages growth in the major                                     little changed in Japan despite the increase in
     advanced economies remains around decade                                              the consumption tax because its effects were
     highs but has eased a bit in the United States                                        largely offset by the introduction of free
     (Graph 1.21). These labour market outcomes                                            preschool education.
     continue to support consumption growth.                                               After trending higher towards the end of 2019,
                                                                                           market-based measures of short-term inflation
     Inflation remains low in the major                                                    expectations decreased in late January following
     advanced economies                                                                    the outbreak of the coronavirus and (related)
     Inflation remains below central banks’ targets in                                     noticeable declines in oil prices. Longer-term
     the major advanced economies (Graph 1.22).                                            market-based inflation expectations remain low.
     Core inflation in the United States has eased
                                                                                           After easing last year, central banks in
                                                                                           major advanced economies are
                                    Graph 1.20
                                                                                           expected to leave policy settings
                      Major Advanced Economies –
                        Labour Market Indicators                                           unchanged for some time
       std                                                                            %
                 Employment intentions*                      Vacancy rates
       dev                                                                                 Central banks in advanced economies left policy
                               United States
         2                                                                            4    rates unchanged at recent meetings, but
                    Euro area
                                                            Japan                          signalled that they are prepared to ease further if
         0                                                                            3
                                                                                           necessary. A number of central banks noted that
        -2                                                                            2
                                                                                           the key risks that prompted pressures to ease
                                                                                           policies in 2019 – including escalation in trade
        -4                                                                            1    tensions and slower global growth – had
                                                                                           receded somewhat. The US Federal Reserve
        -6                                                                            0
                    2009       2014       2019          2009        2014     2019          (Fed), European Central Bank (ECB), and Bank of
             *   Standard deviation from long-run average
             Sources: Eurostat; RBA; Refinitiv                                             Japan (BoJ) indicated that their current policy
                                                                                           stances are likely to remain appropriate in the

                                    Graph 1.21
                      Major Advanced Economies –                                                                           Graph 1.22
                       Labour Market and Wages
                                      Year-ended growth
                                                                                                    Major Advanced Economies – Inflation
        %                                                                             %                                          Year-ended
                       Employment                               Wages*                        %                                                                               %
                                                                                                        United States*            Euro area                  Japan**

                                      Japan                                                   4                                                                               4
         3                                                                            4
                                                                                                        Headline
                                                              Japan part-time

                                                                                              2                                                                               2
         0                                                                            2

                            Euro area                                                                   Core
                                                                                              0                                                                               0

        -3                                                                            0
                         United States                         Japan full-time                -2                                                                              -2

        -6                                                                            -2
                    2009       2014       2019          2009        2014      2019            -4                                                                              -4
                                                                                                         2013        2020         2013        2020         2013        2020
             *   Average hourly earnings for the US; compensation per employee for
                                                                                                   *   Personal consumption expenditure inflation
                 the euro area; smoothed matched-sample average full-time scheduled
                 wages and part-time hourly wages for Japan                                        **  Excludes effect of the consumption tax increase in April 2014
             Sources: CEIC Data; ECB; Eurostat; RBA; Refinitiv                                     Sources: RBA; Refinitiv

14   R E S E R V E B A N K O F AU S T R A L I A
near term, while noting that future policy                                      evidence of a sustained increase in inflation
settings will depend on the resolution of                                       towards 2 per cent. Market pricing suggests that
ongoing uncertainties. Market pricing now                                       the ECB’s interest rate policy settings will remain
implies that central banks in advanced                                          unchanged in the coming year.
economies are expected to either ease a little                                  The BoJ has indicated that it is prepared to ease
further or leave policy rates at around current                                 policy if it considers that there has been a loss of
low levels for some time (Graph 1.23).                                          momentum in inflation reaching the 2 per cent
The Fed lowered the target range for its policy                                 target. The BoJ recently made further
rate by 75 basis points to 1.5–1.75 per cent in                                 adjustments to some aspects of how it
the second half of 2019, in response to subdued                                 implements policy in an effort to improve the
inflation and downside risks to the outlook for                                 sustainability of its current policy stance by
global growth. The Fed has since signalled that it                              mitigating the side effects of its asset purchases
would take a material reassessment of the                                       on the financial sector. In October, the BoJ also
outlook to trigger further changes to policy                                    reduced its purchases of long-term government
settings. Market pricing suggests that the Fed is                               bonds in an effort to steepen the yield curve.
expected to lower its policy rate one or two                                    Following the Japanese Government’s
more times over the second half of the year.                                    announcement of a fiscal stimulus package and
In September, the ECB announced a package of                                    easing in some global risks, market pricing now
stimulus measures, which will continue to be                                    implies that policy settings will remain
implemented over coming years, in response to                                   unchanged this year.
weakening domestic economic activity and                                        The Bank of Canada (BoC) left its policy rate
downside risks to the outlook (Graph 1.24).                                     unchanged in January, after having being on
Governing Council members have stated that                                      hold over 2019 amid a tight labour market and
there had been some tentative signs of                                          inflation near target. However, the BoC stated
stabilisation in economic activity following the                                that growth has eased a little recently and now
slowdown seen in 2019, and that there had                                       judges there to be a little more spare capacity
been a moderate increase in underlying                                          than previously thought. The BoC indicated that
inflation. The ECB’s new President, Christine                                   the policy rate may be lowered if the recent
Lagarde, reiterated that monetary conditions will                               slowdown persists and weighs on inflation.
remain highly accommodative until there is                                      Market pricing implies that the policy rate will

                               Graph 1.23                                                                           Graph 1.24
                     Policy Rate Expectations*                                                      Central Bank Balance Sheets
   %                     US                                                %
                                                                                                             Selected items; share of GDP
                                                     NZ
   2                                                                       2        %                                                                    %
                                Current                                                      European Central Bank                Bank of Japan
   1                                                                       1
                                                                                             Other securities
                                                  Japan                            32                                                                    100
                                                                                             Exchange Traded Funds
   0                                                                       0
                                                                                             Government bonds
                                              Euro area                                      Loans
   %                                                                       %       24                                                                    75
            Canada
   2                                                                       2
                                                Norway                             16                                                                    50
   1                                                                       1
                    UK
   0                                                                       0
                                                                                     8                                                                   25
                                                               Sweden
   -1                                                                      -1
        2017        2019       2021        2017        2019       2021
        *   Expectations for Norway and Sweden are based on central bank             0                                                                   0
            forecasts                                                                        2010            2015     2020    2010      2015      2020
        Sources: Bloomberg; Norges Bank; Sveriges Riksbank                               Source: Refinitiv

                                                                                S TAT E M E N T O N M O N E TA R Y P O L I C Y – F E B R UA R Y 2 0 2 0        15
be lowered by 25 basis points to 1.5 per cent         compensation (Graph 1.25). These movements
     towards the end of the year.                          were unwound in late January as concerns
     The Bank of England (BoE) has stated that             around the potential effects of the coronavirus
     incoming information about the global and             weighed on growth outlooks. Looking through
     domestic economy will guide future interest rate      recent volatility, yields remain at low levels,
     decisions. The BoE noted that slower global           reflecting ongoing subdued inflation,
     growth and elevated Brexit-related uncertainties      uncertainty in the outlook for global growth and
     had weighed on growth in 2019, and spare              expectations that monetary policies will remain
     capacity had been larger than expected.               accommodative. In China, yields have declined
     However, more recent indicators of domestic           following further targeted easing by the PBC
     activity have strengthened. Market pricing            and as the outbreak of the coronavirus
     implies that the policy rate is expected to be        intensified.
     lowered by 25 basis points by the end of the
     year. In December, the incumbent Conservative         Funding costs for corporations have
     Party secured an outright majority in Parliament,     edged lower
     paving the way for passage of the Withdrawal          Corporate bond yields have declined a little
     Agreement Bill. This allowed the UK to formally       further in recent months (Graph 1.26). The low
     leave the European Union under an interim             cost of corporate debt combined with robust
     agreement at the end of January. The full terms       bond issuance reflects strong demand from
     of the agreement need to be negotiated over           investors that are seeking assets with higher
     the course of this year.                              yields than those available on government
     In Sweden and Norway, both central banks              bonds.
     expect policy rates to be little changed this year,   A general narrowing in spreads has occurred
     following a recent cycle of monetary tightening.      despite a slight upward revision to market
     The Swedish Riksbank raised its policy rate by        analysts’ expectations for a rise in corporate
     25 basis points to 0 per cent in December, which      defaults from their current low levels. This
     followed a 25 basis point increase in late            revision appears to have reflected concerns
     2018 and a period of around five years where          about high levels of leverage in an environment
     policy rates had been in negative territory. In       of moderate economic growth. Consistent with
     doing so, it highlighted its concerns about the       this, the share of firms that have received credit
     side effects of a prolonged period of negative        rating downgrades has increased. Market
     nominal interest rates. Norges Bank left its policy
     rate unchanged at 1.5 per cent, after having
                                                                                       Graph 1.25
     raised the policy rate three times in 2019 in
                                                                         10-year Government Bond Yields
     response to a solid domestic growth outlook              %                                                         %

     and concerns related to financial stability.             4
                                                                                           China
                                                                                                                        4

                                                              3                                                         3
     Government bond yields are around
                                                                                                            US
     record lows                                              2                                                         2

     Yields on long-term government bonds remain              1                                                         1
                                                                                                                 UK
     low. Yields have declined recently following a
                                                              0                                                         0
     gradual upward trend late last year, which had                                        Germany

     been in line with moderating downside risks to           -1                                                        -1
                                                                       2016        2017   2018       2019        2020
     growth and higher market-implied inflation                    Source: Bloomberg

16   R E S E R V E B A N K O F AU S T R A L I A
analysts expect defaults to be concentrated at                                 rates seen since late 2018 (which increases the
the lower end of the credit rating spectrum,                                   discounted value of future earnings).
particularly in the energy sector where spreads                                In short-term US dollar money markets, spreads
have remained elevated compared with the                                       (over and above expected policy rates) declined
broader US high yield market.                                                  towards the end of 2019. US repo markets
In China, the cost of funding for corporations                                 functioned smoothly despite a build-up of
has been relatively stable over recent months.                                 funding pressures in the second half of the year,
This is despite a pick-up in corporate bond                                    partly reflecting the Fed’s injection of short-term
defaults, albeit from a low base. In the coming                                liquidity through repos as well as its purchases
months, firms adversely affected by the                                        of Treasury bills (which are underpinning a
coronavirus outbreak may face difficulties in                                  build-up of bank reserves held at the Fed). These
meeting bond repayments. To address this risk                                  measures may have contributed to a reduction
authorities have encouraged investors to extend                                in the cost of funding in US dollars, including in
repayment deadlines for affected firms, in                                     exchange for other currencies (Graph 1.28). The
addition to the range of measures announced to                                 Fed has signalled that it expects to pare back its
support broader financial conditions.                                          repo operations over the coming months as
Global equity prices have risen further over                                   reserve balances in the banking system become
recent months, notwithstanding recent declines                                 more plentiful.
related to concerns around the coronavirus.
Equity prices have risen by around 8 per cent                                  Movements in exchange rates reflected
since the recent trough in September and are                                   an easing in trade tensions and an
around 20 per cent higher than late 2018                                       escalation in concerns about
(Graph 1.27). In the United States, equity prices                              coronavirus
are near record highs. Valuation metrics show                                  The US dollar and Japanese yen depreciated
that much of the increase in equity prices                                     over December and early January, before partly
reflects investors’ increased willingness to pay                               reversing these moves later in January as
for future earnings, rather than expectations that                             concerns related to the spread of coronavirus
earnings will grow at a faster pace than                                       increased (Graph 1.29). The euro has been little
previously thought. This largely reflects valuation                            changed and has remained in a relatively narrow
effects from the substantial decline in risk-free                              range over the past year or so. In contrast, the

                                                                                                              Graph 1.27
                               Graph 1.26
                                                                                                              Global Equities
                   US Corporate Bond Markets                                    index             Equity prices               Price-to-earnings ratios*
                                                                                                                                                          ratio
   %                           Corporate bond yields                       %                  1 January 2015 = 100

    9                                                                      9     160                                                                      21
                                                                                                                              United States
    6                                                                      6     140                                                                      18
            Non-investment grade
    3                                                                      3                 Europe
                                                  Investment grade               120                                                                      15
   %                           Realised default rates                      %
                                                            Average              100                                                                      12
    6                                                                      6
            High yield bonds
                                                                                                      China
    4                                                                      4       80                                                                     9
                                                                                                                                    Average
    2                                                                      2
                   Leveraged loans                                                 60                                                                     6
    0                                                                      0                  2016        2018      2020             2017          2020
            2015         2016          2017          2018           2019                *   12-month ahead consensus earnings forecast
        Sources: ICE Data is used with permission; JP Morgan; RBA                       Sources: Bloomberg; RBA; Refinitiv

                                                                               S TAT E M E N T O N M O N E TA R Y P O L I C Y – F E B R UA R Y 2 0 2 0            17
UK pound has appreciated since around the                                               for competitive purposes, and to disclose
     middle of 2019 as the near-term risk of a                                               relevant information related to exchange rates
     disorderly Brexit diminished. Measures of                                               and external balances in a timely manner. The
     volatility for the major currencies have                                                US Government also determined that China
     continued to decline and are at historically low                                        would no longer be designated a ‘currency
     levels.                                                                                 manipulator’. China’s foreign reserves have
     The Chinese renminbi appreciated further                                                remained stable at around US$3 trillion and
     against the US dollar around the turn of the year,                                      capital outflows have remained within the range
     although it has depreciated more recently as                                            experienced over the past couple of years.
     concerns about coronavirus intensified
     (Graph 1.30). Much of the earlier appreciation                                          Financial conditions in many emerging
     occurred alongside progress on phase one of                                             markets have eased
     the US–China trade agreement. Among other                                               Emerging market equity prices continued to rise
     things, the agreement includes pledges by both                                          through to early January, but have fallen more
     parties to refrain from devaluing their currencies                                      recently as concerns about coronavirus
                                                                                             intensified. Local currency government bond
                                                                                             yields have declined and exchange rates have
                                     Graph 1.28
                                                                                             been little changed (Graph 1.31). There have
                          US Dollar Funding Markets
       bps
                       Overnight repo*                   US dollar funding**         bps     been inflows into emerging market equity funds
                                                    Three-month unsecured rates***
                                                                                             in recent months following an extended period
       200                                                                           80
                                                                  Japan
                                                                                             of outflows. This easing in financial conditions
               Secured overnight
               financing rate (SOFR)                                                         reflects a range of factors including the
       100                                                                           40      continued accommodative global financial
                                                                                             environment and policy easing by many
                                                      Euro area           UK
         0                                                                           0       emerging market central banks during 2019 and
                                                                                             early 2020.
      -100                                                                           -40
               M J S D M J S D M M J S D M J S D M J                                         While financial conditions in emerging markets
                 2018    2019 2020 2018    2019 2020
              *   Spread to effective fed funds rate                                         have generally eased, the outbreak of
              ** Reflects cost of USD funding in the cross-currency swap market
              *** Spread to OIS                                                              coronavirus has introduced a new source of
              Sources: Bloomberg; RBA; Refinitiv
                                                                                             uncertainty and risks remain for some

                                     Graph 1.29
                                                                                                                            Graph 1.30
          Nominal Trade-weighted Exchange Rates
                                     1 January 2015 = 100                                                          Chinese Exchange Rates
      index                                                                          index    index                                                                         yuan

                                     Japanese yen
       120                                                                           120
                                                                                               110                                                                          6.2
                                                                                                                                                   Yuan per US$
       110                                                                           110                                                          (RHS, inverted)
                                                        US dollar                              105                                                                          6.6

       100                                                                           100
                                             Euro
                                                                                               100                                                                          7.0
        90                                                                           90
                                                                                                                          Trade-weighted index*
                                                       UK pound                                                                  (LHS)

        80                                                                           80         95                                                                          7.4
                 2015        2016        2017        2018        2019        2020                         2014    2015     2016      2017      2018      2019        2020
                                                                                                      *   Indexed to 1 January 2014=100
              Sources: Bank of England; BIS; Bloomberg; Board of Governors of the
                       Federal Reserve System                                                         Sources: Bloomberg; China Foreign Exchange Trade System; RBA

18   R E S E R V E B A N K O F AU S T R A L I A
economies with specific political and/or                                                     The outbreak of coronavirus has
macrofinancial vulnerabilities. Social unrest and                                            affected commodity prices
political uncertainty have increased in Latin                                                The iron ore price has declined recently in
America in recent months. In Argentina, the new                                              response to concerns about the near-term
administration has suggested that another                                                    outlook for demand, particularly from China,
round of debt restructuring is close to hand. The                                            following the coronavirus outbreak (Graph 1.33,
central banks of Chile and Brazil have intervened                                            Table 1.1). The outbreak has disrupted some
in the foreign exchange market to support their                                              industrial production and construction activity,
currencies against recent depreciations                                                      which could reduce steel demand, at least in the
(Graph 1.32). In Turkey, the exchange rate has                                               near term. Policy measures announced in China
continued to depreciate despite general                                                      in recent months to support the economy are
sentiment toward emerging markets turning                                                    expected to provide some support to steel
more positive in recent months.                                                              demand, although uncertainty about the
                                                                                             outlook for China and any potential policy
                                                                                             responses is likely to result in some volatility in
                                                                                             the iron ore price in coming months.
                                                                                             Thermal and coking coal prices have increased
                                Graph 1.31
                                                                                             since the previous Statement, but are around
                    Emerging Financial Markets
                                   Excluding China                                           30 per cent lower than a year ago (Graph 1.34).
    %                                                                                index
         Government bond yields*
    8                                                                                140     Rising thermal coal supply from Indonesia,
                                                Equity prices**
    7                                                                                120     Russia and Australia has outpaced demand over
    6                                                                                100
                                                                                             the past year; thermal coal demand has also
    5                                                                                80
                                                                                             eased as competition from gas-fired and
 index           Exchange rates**                                                    %
  100
                (against the US dollar)
                                                                                     30
                                                                                             renewable electricity generation has increased.
   90                                                                                20      Meanwhile, weaker steel production in some
   80                                                                                10      other steel producing economies, including
   70                                                                                0
                                              Cumulative flows to funds***                   India, has weighed on coking coal demand.
   60                                                                                -10
     2012              2016           2020                 2016             2020
         *   Local currency bonds, weighted by market value
                                                                                             The prices of commodities that tend to be most
         ** 1 January 2012 = 100
         *** Includes flows to exchange-traded funds and mutual funds                        responsive to changes in the outlook for global
         Sources: Bloomberg; EPFR Global; IMF; JP Morgan; RBA
                                                                                             demand – particularly oil and base metals –

                                Graph 1.32                                                                                   Graph 1.33
               Emerging Market Exchange Rates                                                                                Iron Ore Market
                   Against the US dollar; 2 January 2017 =100                                 US$/t                                 Spot price*                            US$/t
 index                                                                               index
                                                                                               100                                                                         100
                                   South Africa                                                  50                                                                        50
  120                                                                                120
                    Malaysia                                       Mexico

                    India                                                                        Mt                                  Exports                               Mt
  100                                                                                100         75                                                                        75
                                                                             Chile
                    Indonesia                                                                    50                                         Australia                      50
          Philippines                       Russia
   80                                                                                80          25                                                                        25
                                                                        Brazil                                                                      Brazil
                                   Turkey                                                       Mt                                                                         Mt
                                                                                                                                Chinese imports
   60                                                                                60        100                                                                         100
                                                                                                 90                                                                        90
   40                                                                                40          80                                                                        80
                                                            Argentina
                                                                                                 70                                                                        70
   20                                                                                20                   2015        2016         2017        2018          2019   2020
               2018         2020       2018        2020        2018          2020                     *   62% Fe Fines index; free on board basis
         Source: Bloomberg                                                                            Sources: ABS; Bloomberg; CEIC Data; RBA

                                                                                             S TAT E M E N T O N M O N E TA R Y P O L I C Y – F E B R UA R Y 2 0 2 0               19
have declined recently in response to concerns                                             Lamb prices have declined from their recent
     about the potential impact of the coronavirus                                              peak because of a seasonal increase in supply
     outbreak on global activity (Graph 1.35 and                                                and drought-related destocking.
     Graph 1.36). This more than offset increases in oil                                        Based on partial export price data (including the
     prices earlier in the year, after the US–China                                             prices of non-commodity exports), the terms of
     trade agreement was announced and OPEC                                                     trade are expected to have declined in the
     members agreed to deepen production cuts in                                                December quarter reflecting lower iron ore and
     the first quarter of 2020.                                                                 coal prices for much of the period. The terms of
     Prices for Australian rural exports have increased                                         trade are expected to moderate further over the
     in recent months. Wheat prices have been                                                   next couple of years as demand for bulk
     supported by supply concerns stemming from                                                 commodities eases and more supply comes
     unfavourable weather conditions in key global                                              online.
     producing regions, including in Australia. Beef
     prices increased sharply in late 2019 because of
     strong demand from Asia; however, prices have
     declined more recently because of an increase
     in supply owing to drought-related destocking.

                                     Graph 1.34
                                       Coal Prices
                                     Free on board basis
     US$/t                                                                              US$/t
                       Thermal coal                       Hard coking coal

       150                                                                              300

                     Contract

       100                                                                              200

                   Spot
        50                                                                              100

         0                                                                              0
                  2012        2016         2020       2012         2016         2020
             Sources: Department of Industry, Innovation and Science; IHS Markit; RBA

                                                                                                                              Graph 1.36
                                     Graph 1.35
                                                                                                                  Base Metals and Rural Prices
                              Brent Crude Oil Price                                                                            January 2014 = 100
     US$/b                                                                              US$/b    index                           Base metals                              index
                                                                                                                                                     Zinc
                                                                                                  150                                                                     150
       125                                                                              125                     Aluminium

                                                                                                  100                                                                     100
       100                                                                              100
                                                                                                                Copper                        Lead       Nickel
                                                                                                 index                         Rural commodities                          index
        75                                                                              75                Lamb
                                                                                                  150                                                                     150
                                                                                                                                                     Beef
        50                                                                              50
                                                                                                  100                                                                     100
                                                                                                         Wool                     Wheat

        25                                                                              25         50                                                                     50
             2010         2012          2014         2016         2018          2020                       2014     2015      2016     2017       2018      2019   2020
             Source: Bloomberg                                                                           Sources: Bloomberg; Landmark; MLA; RBA

20   R E S E R V E B A N K O F AU S T R A L I A
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